Select Page

A problem that might occur with prediction markets and governmental policies might be described as the End of the World problem. Suppose we are evaluating a policy that is very good, but has the small problem that is has a 20% probability of causing the end of the world.

Normally, if a prediction market is used to evaluate such a policy, it will decide that it’s a wonderful policy because no one will buy a financial instrument that only pays off if they’re dead. To make it more concrete, consider a typical prediction market that is working with two outcomes: either an event occurs, or it does not. A financial institution, such as a bank, issues pairs of bearer bonds, one of which says “This bond pays $1 on December 31st 2016 if the event has occurred.” The other says “This bond pays $1 on December 31st 2016 if the event has not occurred.” As only one of the two bonds can pay off, and as the bank issues the bonds in pairs, from the banks point of view it is simply issuing bonds that pay off on December 31st 2016. From the point of view of the speculator who buys the pair of bonds from the bank, who thinks he knows that the event will occur, and who keeps the bond that he knows will pay off and sells the bond that he knows is worthless to some poor fool who will pay him good money for a worthless scrap of paper, this is an easy way to make money from the ignorant. Prediction markets allow informed individuals to make money from less informed individuals, and the public gets an informed estimate of the probability of the event. If the price of “This bond pays $1 on December 31st 2016 if the event has occurred” settles at $0.63, then the prediction market has forecast a 63% probability that the event will occur.

Unfortunately, if the “event” in question is the end of the world, this mechanism fails to work. Who will buy a bond that says “This bond pays $1 on December 31st 2016 if the world has ended”? And why not pay $1 for a bond that says “This bond pays $1 on December 31st 2016 if the world has not ended”?

While amusing and harmless if we’re talking about bonds, the result can be disastrous if we’re talking about a DAO Democracy adopting policies that might actually cause the end of the world if adopted. Suppose a DAO Democracy is considering whether to build the Large Hadron Collider (LHC), and suppose (for the moment) that there actually was a consensus in the physics community that there was a 20% risk that turning on the LHC would end the world. How do we discover this risk? We can’t simply have a prediction market based on DCW, as the previous example shows the prediction market will simply ignore the 20% risk that the world will end.26 While there might be better solutions, one method is to fall back on simpler techniques: we could have a committee of qualified experts consider the matter and reach a conclusion by anonymous voting one month before turning on the LHC (or the proposed scheduled completion date of the LHC if the project is not funded). This lets us create a prediction market at the time funding of the project is being considered. This market can be used to determine the probability that the LHC would destroy the world. This probability can then be used in evaluating whether or not to fund the construction of the LHC.

Further research on this problem seems warranted. Fortunately, there aren’t many policies that might destroy the world, making special-case handling feasible if a more satisfactory general mechanism can’t be found.